Ten ‘Biggies’ For 2013

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By Rudi Filapek-Vandyck, Editor FNArena

This will be my final Weekly Insights for this calendar year. 2012 has been volatile, as expected, and full of surprise and boredom at the same time. I am dead certain I am not the only one with mental fatigue when it comes to hearing about the same issues over and over again. (Please excuse me for NOT repeating them).

Next week I am scheduled to quietly move into annual break-mode, but I already know it won't happen. At least not immediately. As we approach the traditional quiet season, there's too much left on my desk that still needs an answer, a solution or otherwise response. I'll still be busy next week, but no more stories and no more market analyses for me until into the new calendar year.

One of my unfinished projects is the e-booklet I promised. Instead of rushing it out before Christmas, I have decided to delay its publication to January. Next week I will be writing the final pages.

Below are my final market observations before we all start looking forward to 2013.

1. The Biggest Surprise

The biggest surprise of 2012. Was it that we all collectively became tired of selling down equities because of European politics? Or was it the fact that equity markets are up double digits when the whole year was scarred and dominated by nothing but bad news?

I knew from history that at some point in the downgrade cycle investors switch to ignoring falling earnings forecasts and start focusing on the earnings recovery on the horizon, but I have nevertheless been surprised by how little earnings forecasts have mattered the whole year. Still is the case. In Australia, this year is again shaping up as a rather miserable one for corporate profit growth and it's not a given that FY14 will simply bring us double digit growth for all and sundry.

The message I am trying to get across here is that sooner or later the prospective earnings growth in Australia will come under scrutiny again and I sincerely hope your portfolios don't fall victim to the Wile E Coyote effect when that moment arrives.

2. The Biggest Threat

Contrary to my first observation, in certain cases earnings growth has very much been at the forefront of the market's attention. Stocks such as Breville Group ((BRG)) and Super Retail Group ((SUL)) have delivered phenomenal results for investors this year and that was very much on the back of strength in earnings growth. Another example that has caught everyone's attention this year is CSL ((CSL)).

Underlying message: there's always room for a strong growth story, no matter what happens in Europe, China or the US.

Having said so, I remain of the view that the Biggest Threat is for investors trying to jump on the market's positive momentum to discover they have a hand granade in their portfolio and the damage done blows out all benefits achieved elsewhere. Recent weeks offer plenty of examples: Ten Network ((TEN)), Western Areas ((WSA)), Boart Longyear ((BLY)), Norfolk Group ((NFK)),.. companies either were forced to scale back market expectations, or they had to come cap in hand for more capital, or both.

Might be my lack of imagination but I really don't see this underlying theme changing in the weeks or months ahead. Call them hand granades, land mines, torpedoes or whatever you like, but stay alert. (Better safe than sorry because you might be really, really sorry).

3. The Biggest Mistake

I have a special relationship with crude oil ever since I was the last voice of reason in Australia back in 2008 when the world en masse went temporarily into an oil craze, and paid for it dearly afterwards. Oil and gas stocks in the Australian share market have a very dubious track record for investors. All those gains everybody's always talking about either occurred before 2008 or they never stick (which makes them more suitable for traders than for investors). By now you all know my favourite market observation, but I happily repeat it again: there have been three rallies of 50% and more for the sector since 2006 – yet most share prices today are still in the vicinity of share prices back then.

Go figure.

As we approach the new calendar year there are -again- plenty of experts and commentators around who are uber-bullish on the energy sector. Yet, notice how crude oil prices have not been following the uptrend in equities of late. Another remarkable observation is that for the first time in many years, oil price forecasts for the year ahead really are all over the shop. What's it going to be? US$140/bbl or US$80/bbl?

I am of the view that many experts and commentators still have to play catch up with the New Energy Revolution in the US. My warning is: do not automatically expect a higher oil price simply because the economic picture might look a little better later into next year. My chips are on "unchanged to lower" in twelve months' time.

4. The Biggest Fad

The Biggest Fad for 2012. Was it dividend yield uber alles? Nope. It was "buy gold stocks because they have underperformed the gold price". Yeah right. Anyone checked the price of Newcrest ((NCM)) shares lately? Perseus Mining ((PRU)) anyone?

Admittedly, for owners of a stock like Regis Resources ((RRL)) 2012 has proved a rewarding exercise, but that's because Regis is at that stage in its development when earnings growth runs at dizzying heights. Forecast growth in earnings per share this year is no less than 185% – it's NOT because Regis happens to be a gold producer. I predict more of the same for 2013. The biggest threat to the gold price right now is a rampant bull market for equities, which just happens to be the reason why Goldman Sachs analysts last week called the peak for gold in 2013.

Stocks like Regis for which growth comes at supersonic speed will still see share price appreciation (see also point 2 – The Biggest Threat).

5. The Biggest Question Mark

I have been talking, writing, analysing and presenting about the virtues of dividends through equities since 2009. Even though this was one of the few strategies that actually proved profitable in 2010 and 2011, it nevertheless took Mr Market until this year to finally catch up and don't we all know it! Telstra ((TLS)) shares are back above $4. CommBank ((CBA)) shares are at their highest multiple post-2007 and even the likes of Westfield ((WDC)) have been clearly outperforming the broader market this year. Time to get a bit more cautious on the theme? Absolutely.

My natural reflex is to turn cautious when The Herd is stomping into one direction. The Herd is a day trader's best friend. For longer term investors, however, history shows share prices always overshoot when The Herd moves in, and sub-par investment results are what lies ahead. I don't know when exactly this Herd Mentality is going to shift focus, but I do know it's better to turn cautious when The Herd has entered the room.

If you happen to be among the many investors looking for "income" and you cannot wait for cheaper prices, I suggest you look for future growth in those dividends and you pare back any short term expectations to the size of those dividends. Accept that at some point capital losses are likely (temporarily) and they may exceed the dividends you are anticipating. Remember that for quality stocks the longer term horizon remains positive, especially when profits and dividends continue to grow.

The Biggest Question Mark for 2013, I think, is how long before fully priced dividend stocks come back down to earth? (Not all of them are of the highest quality, you know)

6. The Biggest Hyperbole

It was 1979 and one US magazine printed "Death of Equities" on its front cover. Yeah, that was a joke. Not that history teaches us anything else than that we keep on repeating making the same mistakes. What was it that experts were talking about last year and earlier in 2012? Oh, I remember: the End of Buy and Hold strategies! Absolute rubbish, of course. Never forget three-quarters of the financial "commentariat" has a direct interest or works for a company that has a direct interest in convincing market participants they should trade in and out of financial assets on a regular basis.

That, plus it is only human to have a rather narrow view on things. Despite the main indices not having been helpful over the past three years, there are plenty of quality growth stocks that paid out healthy dividends and rewarded their loyal shareholders with price gains that didn't melt away at the next inflection point. Technology One ((TNE)), McMillan Shakespeare ((MMS)), Amcor ((AMC)), Ramsay Healthcare ((RHC)) and Coca-Cola Amatil ((CCL)) are only a few of them. Alas, most of the time these stocks are also outside the spectrum of (most) experts, commentators and investors.

Indices are a flawed benchmark. Concentrate on owning the right stocks. Only trade when it suits you. You would have to be very good trader to beat a portfolio with the stocks mentioned above.

7. The Biggest Irony

There is no direct correlation between economic performance and returns from equities. No matter how many research papers are being released that conclude exactly that, investors and commentators will still focus on prospects for economic growth and then make a direct connection with the outlook for equities. Surely, Charles Darwin has been moving around quite a bit in his cask over the past four years. One can only wonder how it was exactly that humans ended up at the top of earth's food chain.

2012 has delivered yet more proof of the non-relationship between the two. European equities are killing it. Japanese equities are forecast to outperform next year. Chinese equities are below levels of 2009. Australian equities, surrounded by the Best Economy in the Developed World, have all but disappointed. And now -irony, oh irony- when the rest of the world is talking "improving prospects" for next year, the opposite might well be true for domestic Australia. Some economists are talking "potential for a technical recession". But interest rates are still heading lower!

Now, what are the chances local equities will actually start outperforming vis-a-vis their international peers, as predicted by some? Anything is possible, but earnings growth better start materialising at some point.

8. The Biggest Elephant

The Biggest Elephant in the Room for investors globally is what is going to happen with government bonds in the developed world, but most of all, US Treasuries?

It is a very rare event when US government bonds outperform US equities over a thirty year period. Now that it's happened, what's next?

Instead of worrying about what might happen to their equities exposure, investors are probably better off starting to reduce exposure to developed world government bonds. Best case scenario: we are in the midst of a once-in-a-lifetime change and yields on government bonds have moved into a new phase, otherwise termed "Japanation". Lower yields for longer? Lower yields means no returns. Alternatively, if those low yields start moving up again, you don't want to be there and neither does your portfolio.

Australians with a Balanced Super Fund should check allocations and limitations of their fund(s). Chances are high a big chunk is invested in offshore bonds and the fund's mandate does not allow to reduce or abandon. This is carnage waiting to happen. (You have been warned).

9. The Biggest Regret

Never listen to an economist for investment advice. I have repeated the mantra a few times on live television and never does any of the economists think it's funny. Yet, I did fall into the trap this year in paying too much attention to economists' projections for mining capex in Australia. The result was that I remained optimistic on mining services providers for too long. Regrets? Yes, I have a few.

The irony was that last year I predicted the sector would go through a genuine Boom-Bust cycle. Key message: even if you know it's all going to end in tears, it remains difficult to pinpoint the exact moment when the tide turns. Note my favourite stock in the sector, Monadelphous ((MND)), is UP for the year and shareholders have in between received a very healthy dividend too!

My other regret is, of course, trying to be too smart by picking Perth-based IT services provider ASG Group ((ASZ)) as an example for a dividend-based investment strategy. Always one that spoils the party. My Biggest Regret for 2012 is called ASG Group.

10. The Biggest Secret

Don't let anyone tell you otherwise: solid, growing dividends beat everything else in the longer run. And it doesn't require you jump in and out of assets every time momentum shifts into another gear. It's the Biggest Secret for investing in the share market (because all those promoters of trading platforms and charting software packages don't want you to find out).

Alas, most investors are rather inexperienced when it comes to dividends and this leads to obvious errors. Number one: dividends are NOT defensive. It's simply another strategy to invest into the share market. Number two: a higher yield is NOT the better proposition. High future growth is. Number three: dividends do not compensate for corporate weakness. This is why David Jones ((DJS)) no longer beats Rio Tinto ((RIO)) shares, but Monadelphous still does! Number four: ignore them at your own peril (Charles Darwin would advise you do otherwise).

Best Wishes for the New Year.

(This story was originally written on Monday, 10 December 2012. It was sent out in the form of an email to paying subscribers on that day).

P.S. I made a promise and already received some questions about it, so here's a brief update on my current e-booklet in progress: "Make Risk Your Friend". I am progressing well in my writings, but it's taking longer than I initially anticipated. As Indicated above, I am working on it and will continue to do so this week and next. January will see its release.

Good news for FNArena subscribers: colleague Greg Peel recently finished an in-depth market update on rare earths elements (REE) which has been published in e-booklet format, for FNArena subscribers only. If you haven't received your copy yet, send an email to info@fnarena.com

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)

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